By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.com

According to Dow theory, the main signals for buying and selling are based on the price movements of the indexes. Volume is also used as a secondary indicator to help confirm what the price movement is suggesting. (For more insight, see Volume Oscillator Confirms Price Movements and Gauging Support And Resistance With Price By Volume.)


From this tenet it follows that volume should increase when the price moves in the direction of the trend and decrease when the price moves in the opposite direction of the trend. For example, in an uptrend, volume should increase when the price rises and fall when the price falls. The reason for this is that the uptrend shows strength when volume increases because traders are more willing to buy an asset in the belief that the upward momentum will continue. Low volume during the corrective periods signals that most traders are not willing to close their positions because they believe the momentum of the primary trend will continue.

Conversely, if volume runs counter to the trend, it is a sign of weakness in the existing trend. For example, if the market is in an uptrend but volume is weak on the up move, it is a signal that buying is starting to dissipate. If buyers start to leave the market or turn into sellers, there is little chance that the market will continue its upward trend. The same is true for increased volume on down days, which is an indication that more and more participants are becoming sellers in the market.

According to Dow theory, once a trend has been confirmed by volume, the majority of money in the market should be moving with the trend and not against it.


Next: Dow Theory: Trend Remains In Effect Until Clear Reversal Occurs »


comments powered by Disqus
Trading Center